Deciphering the Neo-Fisherian Effect

Abstract

The neo-Fisherian effect typically refers to the short-run increase in in?ation associated with a permanent increase in the nominal interest rate. This positive comovement between the two variables is commonly viewed ? and empirically identi?ed ? as being conditional on permanent monetary shocks, which are often interpreted as permanent shifts in the in?ation target. Such a view, however, implies that in?ation and the nominal interest rate share a common stochastic trend, a property that is hardly supported by the data, especially during episodes of stable in?ation. Moreover, in countries that have adopted formal in?ation targeting, changes in the in?ation target occur very infrequently, if at all, calling into question the interpretation of in?ation target shocks identi?ed within standard time-series models based on quarterly data. In this paper, we propose a novel empirical strategy to detect the neo-Fisherian effect, which we apply to U.S. data. Our procedure relaxes the commonly used identifying restriction that in?ation and the nominal interest rate are cointegrated, and, more importantly, is agnostic about the nature of the shock that gives rise to a neo-Fisherian effect. We ?nd that the identi?ed shock has no permanent effect on the nominal interest rate or in?ation, but moves them in the same direction for a number of quarters. It also accounts for the bulk of their variability at any given forecasting horizon, while explaining a non-negligible fraction of output ?uctuations at business-cycle frequencies. Using Bayesian techniques, we show that the data favors the interpretation of the identi?ed shock as a liquidity preference shock rather than an in?ation target shock. Show more